To assess the solvency of a company or an individual, a special calculation is made in which the ratio of the security of financial obligations with assets takes part. In order to understand what this indicator shows and why it is needed, the issue of enterprise sustainability should be studied in detail.
What is the financial stability of the company
Very often, financial sustainability of an enterprise is understood to be not quite what is meant by this term in financial analysis. Namely, financial stability in the household sense is the ability of an enterprise to withstand the blows of financial fate, to pay for unforeseen obligations, to pay bonuses, to respond to the challenges that the environment presents. I must say that for this ability in financial analysis there is also a term, but another. The ratio of assets to financial liabilities, the value of which will be presented below, is very important.
Financial stability
In financial analysis, financial stability is understood as a very specific thing and the minimum conditions for financial stability are identified. The first of these is the excess of non-current assets over capital.
Non-current assets are assets that have been used for more than a year. These include cars, buildings, land. If non-current assets are more than capital, this means that the difference between the two concepts is greater than zero.
The second minimum financial condition is the excess of inventories over debt loans. But if the first condition is not fulfilled, then the second condition is simply not considered.
Consider your own working capital, and why it should be above zero. If non-current assets are taken away from equity, then this difference can be called own working capital. We buy working capital for equity. To understand why this is so important, consider what happens if the first condition of financial stability is not met.
Suppose non-current assets are financed by equity and unpaid dividends. What happens if the company is suspended? In this case, short-term liabilities to counterparties will be repaid in cash and receivables. In this case, part of the receivables will be lost.
Among the stocks will be illiquid. Therefore, to repay long-term loans will have to sell part of non-current assets. Assets will be sold at a loss in value. If there is no own working capital, the shareholders receive less equity.
Enterprise sustainability stages
Several stages of financial stability are determined.
The first stage of financial stability is when there is enough equity to finance non-current assets and to cover inventories. The first stage of financial stability is called absolute.
The second stage: non-current assets and inventories are fully financed by equity and long-term loans. In this situation, financial stability is considered normal. We will repay short-term liabilities with money and debtors and pay dividends. Inventories and non-current assets will guarantee the repayment of long-term loans and equity.
What are volatile financial conditions?
Unstable financial conditions are most often encountered when inventories are partially financed by certain short-term obligations to counterparties. These obligations may be permissible, that is, constitute short-term loans, suppliers, as well as dividends of a closed joint-stock company, if the owners agree with this. But unacceptable sources can be used - short-term obligations. These include: wage fund, delay in payment of deliveries beyond the “normal” delay, taxes, dividends of an open joint-stock company.
If we use these sources to finance inventories, then in this case the corresponding stage of financial stability will be called critical. The critical financial condition is developing sequentially. First, the company delays the payment of suppliers' bills, which is the norm.
After that, the company delays the payment of dividends. Then the company delays salaries and delays the payment of interest to the bank and taxes.
Financial stability indicator
To analyze the solvency of the enterprise, that is, financial stability, the ratio of financial liabilities to assets is used. This is an indicator characterizing the solvency of the company to make settlements on its obligations after all its goods that are on its balance sheet are sold. It is worth sorting out in more detail.
The ratio of financial liabilities to assets can be determined by the ratio of all liabilities of the enterprise to the total value of assets. In the calculation process, the accountants do not use the reserves of expenses that are to be paid. Using the security ratio, you can determine whether the company will be able to pay its obligations at the expense of assets that have been converted into cash.
If in the process of calculation it was revealed that the indicator of the coefficient of provision of financial liabilities with assets for the year increased from 1.6 to 2.6, this suggests that the company has created a reserve stock that is able to cover all expenses and losses arising in the reporting period. The increase in the coefficient was due to an increase in the sources of finance, with which working capital was purchased.
How to calculate financial stability indicator
For financial analysis, accountants use special formulas with which you can obtain data on the financial viability of the company. The ratio of assets to financial liabilities, the formula of which is given below, is very important for financial reporting.
K = (D + K + P) / WB, where
- K is the coefficient;
- D - long-term obligations of the company;
- K - short-term obligations of the company;
- P - upcoming reserve of expenses;
- WB - balance sheet currency.
Consider the conditions.
If the K3 financial asset security ratio is below 0.85, then the company has weak financial stability and a large share of external borrowed funds and sources of financing.
Coefficient calculation example
Consider this formula as an example.
Suppose you own a network of pharmacies. Your capital is 50 million rubles, long-term liabilities - 40 million rubles, and the balance sheet currency - 95 million rubles. Having all the data, substitute in the formula:
(50,000,000 + 40,000,000) / 95,000,000 = 0.95.
As a result, we obtain the ratio of assets to financial liabilities, the standard of which is from 0.85 to 0.95. In this example, the coefficient is 0.95, which is normal. This means that this company can be considered financially stable. She can quite successfully pay her long-term bills.
Conclusion
In conclusion, we conclude that the ratio of financial liabilities to assets shows at what level is the stability of the enterprise, whether the company will be able to pay its debts. The coefficient should be normal, not lower than 0.85. It can be applied over many reporting periods.